The first change I noticed was early last week, before any state of emergency had been declared in Rhode Island, Massachusetts, or the US. Suddenly, my commute was far easier than usual. I hit every light and breezed into work. By the end of the week I had shaved 20% off my commute time. I saw it as the first sign that personal habits were changing. Consumer demand was starting to drive economic expectations, and the markets took notice.
Why have the Markets Collapsed?
This crisis is first and foremost a health care issue. The impending economic crisis is a direct result of how governments, businesses and individuals have chosen to fight this viral threat. In order to win the war for public health and safety, governments around the globe have been requiring social distancing, quarantines, travel bans and even lockdowns to defend against a pathogen which, if unchecked, could result in a dramatic loss of life and serious medical and economic consequences. With urgency increasing each day, dramatic measures that require personal sacrifice on everyone’s part are being instituted on a temporary basis. As a result, economies are starting to shut down, and the likelihood of a global 2020 recession (including in the US) has dramatically increased in the last week.
The markets aren’t blind to struggling businesses, such as airlines, hotels, restaurants and sports stadiums. Markets know that when people stay home, they spend less. And when businesses lack customers for long enough, they lay off workers, resulting in declining incomes and reduced production. By definition, a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” (National Bureau of Economic Research.) By shutting down parts of the economy to forestall the virus, the US is making the conscious decision to sacrifice short term economic wellbeing for the longer term public good. The greater possibility of a recession is one thing markets were factoring in last week when they melted down to a (-27%) pull-back before rebounding 9% on Friday.
Here is a way I like to think about the velocity of the market’s decline.
Governments want their populations to remain calm. While serious changes to behavior are necessary, everyone is warned not to panic. Ironically, markets want the government to be unnerved. Without urgency, government responses typically are reactive, lagging and subject to endless bureaucratic wrangling.
While I regularly talk about the impersonal, computerized nature of trading, markets can and often do have a voice. Sometimes, like now, that voice is akin to shouting. “This is what I will do if you don’t give us a “shock and awe” response to this crisis.” This past week the markets got the attention both of Congress and the President, resulting in a national state of emergency and a substantive relief package for working families.
When will we see the Bottom?
Bottoming is a process. Do not think that because markets crashed last week and then rebounded that the turnround is already here. Lows are often tested one or more times, and new lows can be formed before the markets regain a sustained upward trajectory.
While the markets may be anticipating a recession, on the way down they tend not to discriminate as to whether we are actually in a recession. They are simply selling until buyers who are willing to re-enter the market end the de-escalation in prices. According to Strategas research, since 1950 major S&P declines accompanied by a recession have averaged (-25.2%), while declines without a recession have averaged (-23.1%). Not much of a difference overall. Of course, individual occurrences, such as the dot-com bubble drawdown (-49.1%) and the 2008 credit (debt) crisis (-56.8%) can be much worse, but many business cycle recessions (focusing on unemployment, production and income) are milder.
As for this particular bear market? COVID-19 is a classic “known unknown.” As such, markets are likely to factor in the worst-case scenario. That means investors should expect more downside until the virus in the US is manageable and the health care system is healthy enough to handle anticipated caseloads.
What Happens Next?
What happens next depends on the depth of the economic downturn and how long it lasts. For now, we are taking a cue from David Kelly, Chief Global Strategist at JP Morgan Asset Management, who said, “2020 will be the year of the virus and 2021 will be the year of the recovery.”
While much remains uncertain, we believe that the danger from the virus is self-limiting. At the outside it will last until a vaccine is created and widely distributed. That leaves us with the uncertainty of the depth of the economic downturn, which will depend on the following:
- Sufficient government help. We have already seen two rescue relief bills. The first was an $8.3B emergency coronavirus spending package signed March 6th designed to shore up the health care system through prevention efforts and research. A second COVID-19 pandemic stimulus package was created to provide support for families caught in the fallout of virus. This bill will most likely pass the Senate and be signed into law early this week. But there will need to be more appropriations including support for small businesses and certain industries, if we are to keep the economy strong enough to enable a rapid recovery.
- A resilient financial system. Banks are stronger than in 2008 and are not the focal center of the problem. However, that does not mean they aren’t being tested. Low interest rates eat into revenues and loan defaults are an increasing possibility, especially in the energy space. Still, banks are expected to be a stable conduit for economic activity throughout this crisis. In addition, the administration is encouraging public/private partnerships with large corporations, working together to speed up the COVID-19 testing process and support our healthcare system. However, there are a few cracks appearing in portions of the bond market due to lack of liquidity. So far, the Federal Reserve has been addressing this issue and it is assumed they will continue to do so.
I will leave you with this. When clients have asked me whether we are concerned about the dramatic drop in stock prices, I have responded that of course we are concerned. I remind them, however, that this is a healthcare emergency that has had to use the economy to save lives and protect our invaluable medical community. Markets have fallen many times before and have always come back. An economic downturn may be required to avoid devastating consequences of the coronavirus. If that happens, rest assured StrategicPoint will be there to help you through the difficult times.
For now, each of us should focus on taking care of ourselves and each other. Guide your behavior accordingly, and above all else stay healthy and safe.
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